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Waterfront properties are still marketed as desirable but rising sea-levels may render thousands of them uninsurable, sending their values into freefall and resulting in fiscal risks for banks and the government, writes Lynn Grieveson.

Last year a neighbour wandered over to mention she was planning to sell up and move to the Kapiti Coast, where she was eyeing up properties right on the waterfront.

Remembering the outrage in 2012 when Kapiti Coast District Council tried to add coastal erosion zones to LIM (Land Information Memorandum) reports (but was forced to back down after a High Court challenge), we raised our eyebrows and asked: “aren’t you worried about rising sea levels?”

This is the attitude, from both homeowners and policy-makers, that a new report commissioned by the Deep South National Science Challenge warns could lead to chaos and fiscal risk for individuals, banks and the government.

The “Insurance, Housing and Climate Adaptation” report says people often make poor decisions when faced with uncertainty.

“They can over-react to small threats and exhibit optimism bias when risks are higher. They often discount future events heavily,” says the report, prepared by Motu and Public Policy Research, Victoria University.

“These same obstacles and barriers faced by homeowners and renters also afflict policy-makers and the private sector.”

Uninsurable and a fiscal risk

Our neighbour didn’t end up buying that waterfront property, but if she had she may have found herself unable to get insurance cover for it in the future, with the report warning that climate change could challenge the existing insurance arrangements people rely on.

“At some point in the future (time unknown), there are going to be thousands of properties … which will no longer be insurable by the private insurance companies,” says Ilan Noy, Victoria University professor of the economics of disaster, and co-author of the report.

“This may happen gradually or suddenly in response to a big event in New Zealand.”

And that will have risks, not only for the homeowners, but for banks and the government.

The report points out that there are nearly 44,000 homes less than 1.5 metres above the current average spring high tide. Over 8,000 of those are less than 50cm above the spring high tide mark. With sea levels predicted to rise 30cm by 2065 and increasing storm surges and king tides expected, many of those homes are at risk of frequent inundation or being completely washed away. By 2100, global average sea levels are predicted to rise 1 metre if current carbon emissions levels continue.

If insurers pull out from providing cover for homes deemed high risk, homeowners will no longer have any protection from the risk that they may lose their major financial asset – which will, in any case, be slashed in value and potentially unmarketable.

They may look to the government to provide alternative cover (as has happened in some places overseas), or expect the government to step in should their home be destroyed or rendered uninhabitable.

This could be through the EQC or potentially another Crown entity set up to deal with climate change, which Parliamentary Commissioner for the Environment Jan Wright has likened to “a slowly unfolding red zone”.

EQC premiums are collected by insurers and embedded within residential insurance policies, so if private insurers withdraw, homeowners would have to apply directly to the EQC for catastrophe insurance.

“Retreat by private insurers from particular locations could increase the unfunded fiscal risk to the Crown associated with private property in natural disasters, should the Crown elect to provide a backstop insurance,” the report says.

Currently the EQC does not cover damage to land from coastal erosion (although it does cover storm and flood damage to land) and it does not cover damage to residential structures or contents from storms, floods or coastal erosion.

Historically, 85 percent of EQC's land claims have been for less than $20,000 and it is often possible to remediate the damage to the land. But where land has completely disappeared – been washed away – full compensation would be required and the report warns that this could see a significant rise in EQC's exposure.

This in turn could see international reinsurers (who provide "insurance for insurers") dramatically increase their premiums, resulting in higher insurance costs for all New Zealanders.

"If international reinsurance markets harden, reinsurers will also likely place greater scrutiny on EQC's exposure to storm surges and flooding, potentially increasing their prices or even refusing to reinsure this traditional cover for land."

"Insurance is there to transfer risk when the sudden and unexpected
occurs. It has no role in providing cover where loss is certain."

Tim Grafton, Insurance Council CEO, agrees that property owners are being too slow to grasp the reality of the climate change threat.

“The evidence for this is the fact that coastal and cliff-top properties command a premium in the housing market. I see real estate agents selling houses on the basis that the house could not be closer to the sea,” he says.

"I really believe the reluctance to grasp the nature of the natural hazards is a bias or denial factor, that is, people do not believe it will happen to them in their lifetime."

“Insurance is there to transfer risk when the sudden and unexpected occurs. It has no role in providing cover where loss is certain or very high risk for several reasons - and that applies to public and private insurance schemes.”

But Grafton softens Noy's warning that "this is likely to be a very chaotic transition", saying the insurance industry would respond in a gradual and "predictable" way. He says "signalling" through increased excesses has already begun.

"A chaotic transition for the insurance industry in New Zealand is highly unlikely if not remote. I cannot think of any single climate change event that will come close to the cost of major earthquakes and the insurance industry has coped very well indeed to meeting those challenges," he says.

"Gradual signalling will continue to occur, but there are pockets of properties where insurers have started signalling based on frequent loss events and the likelihood of further events."

"In the Flockton Basin in Christchurch before the council invested in adaptation measures (widening culverts and installing pumping stations to reduce the frequency of flooding) the response was to increase excesses, that is the amount an insured would have to meet first for flood damage."

Banks watching the water too

But, as Grafton points out, it is not just insurers and councils grappling with the climate change threat.

The report warns that climate change "could precipitate home loan defaults because of the maturity mismatches between residential insurance and mortgages."

"While mortgages are often granted with repayment periods spanning decades, insurance contracts are renewed annually. Insurers are thus able to completely exit an insurance market within 12 months, while a lender may still have decades before their loans mature."

"Insurance retreat could leave some lenders with a portfolio of assets in technical default."

The banks response is to call for insurers to provide longer-term cover.

New Zealand Bankers’ Association chief executive Karen Scott-Howman confirmed to Newsroom that "the main issue" for the banks "appears to be the mismatch between annual insurance cover and longer term mortgages."

"Longer term insurance products would be welcome by both homeowners and lenders to help address this issue," she said.

“While we’re not aware of new lending being declined on coastal properties, it’s certainly an issue that banks will have to take into account over time.

“Lending decisions on any property are made on a case by case basis. It’s quite possible that in time banks would require more equity or shorter term mortgages when considering lending on potentially affected coastal properties.”

The hope seems to be that the value of at-risk coastal properties will gradually drop, eventually minimising the exposure of both banks and insurers.

"Banks will increasingly look at how much they are prepared to loan and for how long on certain properties," Grafton says.

"If they become less prepared to provide 30 year mortgages on properties that will be lapped by the sea in 30 years’ time and may be only prepared to loan out for 10 or 15 years, then that mortgage will be more costly. The more costly borrowing becomes for certain properties, the less demand there will be for them and that will have an impact on price and desirability," he says.

"Actions by councils in terms of LIM information or even future regulatory action can also make properties less desirable, so these issues can be tackled on a number of fronts, not just insurance."

Of course, one result of the value of coastal properties going into freefall after being deemed at-risk or uninsurable is that they could become the preserve of the low-income and financially vulnerable, who will then bear the brunt of rising sea levels.

The report calls for research into six key areas, including how sea-level rise risk should be allocated across homeowners, insurers and the government, what policy options are available to local and central government when that "tipping point" of uninsurability is reached, how the housing market will be affected and what financial instruments or institutional arrangements could be developed to mitigate risk and ensure housing markets continue to function.